Jurnal BPPK: Volume 1, Nomor 4, Oktober 2010

JURNAL BPPK
Volume 1, Nomor 4, Oktober 2010
Financial Development and Economic Growth:

an Empirical Analysis of Indonesia
Oleh :
Muh Dularif
93 Jurnal BPPK Vol. I Tahun 2010

Muh Dularif
Financial Development and Economic Growth:

an Empirical Analysis of Indonesia
oleh : Muh Dularif
Abstract
This paper empirically investigates the relationship between financial

development and economic growth in Indonesia. A vector autoregressive model using
time series data between 1968 and 2009 presents this dynamic relationship. Financial
depth, the role of commercial banks, and credit to private sectors are three
measurements of financial development used in this paper. However, differing from
much empirical research in developed countries in which financial systems are well-
behaved, the results of this research suggest that financial development in Indonesia
does not have a significant positive impact on economic growth. The main factor in the
failure of financial development in promoting growth is lack of fundamental factors in
the financial system. These factors are lack of credibility of the monetary regulator,
weaknesses in financial regulations and supervision, lack of a legal system and an
ignorance of good corporate governance in the financial sector. In particular, there is
no evidence that financial liberalization will promote economic growth if it is done
without the development of a strong financial system.
Keywords: financial development, economic growth, vector autoregressive (VAR).
Pegawai pada Direktorat Jenderal Pajak

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1. Introduction investors. The overall impact was growth

of 7 percent annually on average during
The relationship between the 1980s to 1990s and Indonesia was
financial development and economic included in the Asian Miracle countries.
growth has been studied extensively in However, consistent with Demirguc-
recent years. However, many researchers Kunt and Detragiache (2001), financial
have recently turned to two contradictory liberalization without prudent policy and
conclusions about whether financial inadequate institutional structure will
development has a positive impact or increase the probability of a financial and
not. As reported by the World Bank an economic crisis. Their prediction
(WB) and International Monetary Fund became reality in 1997 where the Asian
(IMF) (2005), the experience of many financial crisis hit Indonesia and shrank
countries demonstrates that financial the Indonesian economy with growth of
liberalization has two opposite effects in almost minus 15 percent.
the economy. On the one side, In general, the empirical research
development of the financial sector can on the relationship between financial
encourage economic growth, but on the liberalization and economic growth can
other side, the fragility of the financial be divided into two approaches. The first
sector can create an economic crisis and is in terms of bank-based financial
hamper growth. Furthermore, Zagha et system and the second is in terms of
al. (2006) claim that several countries market-based financial system. As noted
gained an increase in saving rate and by Chakraborty and Ray (2006), with a
more access to credit, accordingly, market-based system, the financial
increase investment and encourage market allows debtors to obtain funds
economic growth. However, directly from lenders in the form of
liberalization of the financial sector in financial instrument transactions such as
many developing countries which started in the stock or bond markets. In contrast,
in the late 1980s and 1990s also created in a bank-based market, the banking
traditional macroeconomic problems, system plays a dominant role as
such as government and private debt intermediaries between lenders and
problems, volatile exchange rate and borrowers. Furthermore Thangavelu et
unsustainable fiscal policy. al. (2004) point out that in the bank-
Like many developing countries, based system, financial intermediaries
Indonesia also moved to liberalize the influence economic activity by
financial sector in the 1980s. As increasing the saving rate, providing
expected, initially, financial liquidity, and mobilizing funds to the
liberalization in Indonesia had a positive most efficient investors in the economy.
impact on the economy. The banking On the other hand, a well-developed
sector was able to accumulate funds from capital and bond market can create better
the public then distributed credit to allocation and diversify risks.

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Similar to many developing price level is measured by consumer

countries, the economy and financial price index (CPI).
system in Indonesia is dominated by the The idea that financial
banking system as the intermediary liberalization has a positive impact on
institution. As noted by Beck et al. economic growth is found by
(2000), on average, in the period 1981- Schumpeter (1934), who argues that the
1990 and 1991-2000, the deposit money development of the financial sector is an
bank assets / GDP was 26.67 percent and important aspect for economic
50.49 percent respectively, whereas in development via technological
the same period the capital market innovation. Furthermore, Gultom
capitalization / GDP was only 0.66 (2008b) emphasizes that financial
percent and 22.61 percent respectively. development can encourage per capita
In addition, according to Rosser (2002) income, increase productivity and
until 1977, the capital market in investment efficiency, and consequently
Indonesia was inactive as a result of have a positive impact on economic
President Soekarno‘s policy to growth in the short and long term. A
nationalize Nederland-owned companies similar argument of the positive impact
and stop the operation of the Jakarta of financial development on growth is
Stock Exchange. Until the 1990s, the also proposed by McKinnon (1973) and
capital market grew slowly due to the Shaw (1973) who suggest that financial
regulation that foreigners were liberalization would increase savings,
prohibited from involving in the accumulate capital, encourage
transactions on the Jakarta Stock investment and therefore stimulate
Exchange. Therefore, in this study, the economic growth. Using a model of
empirical research on the relationship prediction that links development,
between financial liberalization and savings, growth and income distribution,
economic growth is limited to bank- Greenwood and Jovanovic (1990)
based market approach. conclude that financial development can
There are several indicators of create opportunities for higher rate of
financial development in the literature. In return on capital, more efficient
this study, following Ang and McKibbin investment, and so impact positively on
(2007) and King and Levine (1993a), economic growth. Bencivenga and Smith
financial liberalization is measured by (1991) compare the model of an
M2 to Gross Domestic Product (GDP) economy, with financial intermediaries
ratio, commercial bank assets to total and without intermediaries. The
bank assets ratio, and the ratio of private comparative models show that with
credit to GDP. Economic growth is financial intermediaries the economy
measured by real GDP per capita. will grow higher than without financial
Nominal interest rate of credit is used as intermediaries by decreasing the reliance
a measurement of interest rate level, and on self finance and avoiding the early

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liquidation of capital investment. Other Several recent empirical studies

theoretical frameworks of the on the relationship between financial
relationship between financial development and economic performance
development and economic growth are also show the positive impact of
also developed by Levine (1991), King financial liberalization on growth. For
and Levine (1993a), and Bencivenga et example, Thangavelu et al. (2004)
al. (1995). investigate the relationship between
In their empirical research, King economic growth and financial
and Levine (1993b) use the model based liberalization in Australia using a VAR
on the endogenous technical change model in terms of market-based and
theory developed by Romer (1990) to bank-based financial structure. They
analyze the link between financial conclude that financial development has
development and growth. Using five a positive impact on economic growth,
countries data from 1974 to 1989, they but economic growth does not have an
point out that financial development has impact on the financial market.
a positive impact on economic growth by Hondroyiannis et al. (2005) examine the
improving efficiency, mobilizing link between financial liberalization and
resources, diverting and reducing risk economic growth in Greece during the
and encouraging innovation. Murinde period 1986-99. They conclude that
and Eng (1994) examine the relationship financial liberalization and economic
between financial restructuring and performance influence each other.
economic growth in Singapore using a Ranciere et al. (2006) conclude that
supply-leading and demand-following financial development encourages faster
finance approach. Their results suggest long-term economic growth, although
that financial development influences there is a risk of a crisis.
economic growth through a supply- Although much research in this
leading channel. Demetriades and area concludes that financial
Hussein (1996) examine the link development influences economic
between financial development and growth, there are several empirical
growth using time series data from 16 studies that come to a different
countries with a vector autoregressive conclusion. For instance, Ang and
model. Their results demonstrate that in McKibbin (2007), using financial and
general financial liberalization has a macroeconomic data of Malaysia over
positive effect on economic the period 1960–2001, demonstrate that
development. Levine et al. (2000) using although the financial reform process can
both GMM-dynamic panel techniques enlarge the financial system, financial
and traditional cross section IV- development does not appear to
procedures show that financial stimulate economic growth. Elbourne
development is positively correlated with and de Haan (2006) using data from
economic growth. central and eastern Europe, conclude that

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there is still an unclear relationship problems, the government established

between financial liberalization, the Indonesian Banking Restructuring
monetary policy and output. Liang and Agency (BPPN). Another fundamental
Teng (2006) investigate the link between change was implementing an
financial development and economic independent monetary policy for the
growth of China using data between Central Bank. Second, during the 1980s
1952 and 2001 with a vector and 1990s, Indonesia was included in the
autoregressive model. Their results show Miracle Asian countries, and one factor
no evidence that financial development viewed as a driver in economic growth
encourages economic growth. On the was liberalization in the financial sector
contrary, their research suggests that (Visser and Herpth (1996). However, the
economic growth promotes financial same factor also appears to be the most
development. In addition, Matsumoto important aspect that shrank the
(2007) points out that financial Indonesian economy after the 1997
liberalization without an adequate financial crisis (Matsumoto (2007).
institutional structure and prudent Finally, the availability of annual data of
supervision are the most important the financial system over the period
factors that create financial and 1968-2009 is long enough to tolerate an
economic crises. empirical investigation using time series
Although considerable research data.
has been done on the relationship The main question in the
between financial development and research is whether financial
economic growth, but much less is liberalization in Indonesia plays a key
known about the role of financial role in promoting economic growth, or
development in promoting economic vice versa. Another problem is to
growth in the country with lack of identify the factors that influence the
institutional structure and problematic relationship between financial
legal system such as Indonesia. development and economic growth.
Indonesia is selected as a study case for The purpose of this research is to
three reasons. First, Indonesia has a long- investigate the relationship between
history of financial reform. Beginning in financial development and economic
June 1983, Indonesia started to move performance in Indonesia using annual
from financial repression to financial time series data over the period of 1968-
liberalization. The Asian financial crisis 2006. This research extends the
in 1997/1998 forced Indonesia to change investigation to find the factors that
fundamental factors in the financial influence the effect of financial
system. As pointed out by Gultom development on economic growth. This
(2008c), to avoid a further crisis in the research uses vector autoregressive
financial system as a result of banking (VAR) models and Granger causality
insolvency and non-performing loan tests to analyze the relationship.

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In contrast to Schumpeter (1934) feel richer, so they will be encouraged to

and King and Levine (1993b) who find increase spending. Firms that produce
that financial development has a positive goods and services will respond to the
impact in promoting growth, the results rise in demand by selling more products.
of this empirical research suggest that To increase production firms need more
financial liberalization in Indonesia does raw materials, more labor, and other
not play a key role in economic growth. inputs. This cycle will boost aggregate
Conversely, economic performance consumption and production, and
influences the growth of credit to private stimulate economic growth. However,
sectors, but does not influence the Schwartz (1987) points out that if the
development in monetary deepening and money persists to increase and economic
the role of commercial bank assets. The growth has reached a limit, prices will
result also support the argument of rise, and the public starts to expect a
Demirguc-Kunt and Detragiache (2001) higher price level, and finally, an
that financial liberalization is not the increase in money supply only creates
most important aspect to encourage inflation. Conversely, Samuelson and
economic activities if there is lack of Nordhaus (2005) maintain that if output
proper regulations and weak institutional increases, income or return of factor
infrastructure. productions also increases, and the
The remainder of this paper is public needs more money. As a result,
structured as follows. Section 2 presents central bank should increase money
the theoretical framework. Data are supply to fulfill the increase in money
presented in Section 3. Section 4 demand.
presents methodology. Section 5 presents Commercial banks as financial
the results, followed by an analysis of the intermediaries play a key role in
results. Finally, the conclusions and economic activity. According to Levine
policy implications are presented in (2001), commercial banks facilitate
Section 6. saving mobilization, capital
accumulation, and efficient allocation of
2. Theoretical Framework funds from savers to borrowers.
Consequently, the increase in the
There are many theories about capability of banks will increase
the relationship between the financial investment and boost growth.
sector and the real sector. Theoretically, Conversely, Samuelson and Nordhaus
output and price level will respond to a (2005) show that bank assets are
change in money supply, change in bank influenced by savings and time deposits,
assets and credit. Friedman and Schwartz while savings are influenced by income
(1963) argue that, if money supply and economic activity.
increases, initially, money in the hand of King and Levine (1993b) claim
customers will increase and make them that banking credit to the private sector

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will be used in the most efficient way The second indicator of financial
since the objective of the private sector is development is the ratio of commercial
maximizing profit. The increase in bank assets to total bank assets
efficiency will encourage productivity (commercial plus central bank assets).
and output. Conversely, financial As proposed by King and Levine
intermediaries also want to ensure (1993a), this measurement indicates the
profitability of their credit. role of commercial banks in the financial
Consequently, when they give credit to system. This indicator assumes that the
borrowers, the amount of credit and commercial bank will maximize profits
interest rate should be adjusted with the by allocating credit to the most efficient
prospect and the risk of the creditors‘ project. So, the larger the relative
project. Since the level of economic importance of the commercial banks in
activity influences the success of an the overall banking system, the higher
investment, economic growth will have the level of financial development of the
an impact on the credit distributed to country.
private sectors by the banking system. The ratio of private sector credit
to GDP is the third indicator of financial
3. Variables and Data development. The World Bank (WB) and
International Monetary Fund (IMF)
The selection of variables as (2005) point out that this ratio indicates
indicators of financial development is properly the role of intermediaries in
important in empirical studies related to distributing funds from savers to
financial development or financial borrowers. Furthermore, this indicator is
liberalization. According to the World based on the assumption that the private
Bank (WB) and International Monetary sector always tries to act efficiently in
Fund (IMF) (2005), there are several allocating and using capital.
indicators of financial development in Hence, in this study, we use the
the literature. The first indicator of ratio of M2 to GDP as an indicator of
financial development is financial depth, financial deepening, the ratio of
where the ratio of M1 or M2 to GDP is commercial bank assets to total bank
used as a measurement of financial assets as an indicator of the role of the
deepening. This indicator seems to be a commercial banking sector, and the ratio
poor measurement of financial of private sector credit to GDP as an
development since it is based on indicator of an efficient allocation of
monetary aggregates, which do not funds in the economy. Then, real GDP
indicate the ability of the financial per capita is used as an indicator of
system to distribute funds from savers to economic growth. Furthermore,
borrowers. However, this indicator is following Lago-González and Salas-
widely used in empirical researches Fumás (2005), one possible channel for
because of the availability of data. financial development in influencing

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economic growth is through interest rates (1)

where, theoretically, a decrease in FDt = f (Yt, It, Pt)
interest rates will encourage investment
and economic growth. So, to capture this Where FDt refers to financial
channel, the interest rate and price level development indicators, Yt refers to the
are included in the vector autoregressive level of economic growth, and It refers to
model. interest rate and Pt refers to price level.
Most of the data come from the However, when we use macroeconomic
international financial statistics (IFS), variables, endogeneity can be a problem.
covering annual data for Indonesia So, according to Enders (2004) treating
during the period 1968 to 2009. Some each variable symmetrically is a
data between 1968 and 1970 are obtained common extension of transfer function
from the Asian Development Bank, UN analysis. In this case, a vector
statistics, Indonesian Central Bureau of autoregressive framework will encounter
Statistics, and the Bank of Indonesia. All the problem by assuming all variables
data but interest rate are transformed into involved in the model are endogenous.
natural log. Furthermore Sims (1980) maintains that
a VAR model will capture dynamic
4. Methodology analysis, resolve identification problems
and a VAR model is better for policy and
Based on this theoretical forecasting analysis.Following Enders
framework, we model the relationship (2004), an n-equation VAR can be
between financial development and modeled as:
economic growth as:
x1t A10 A11 ( L) A12 ( L) . A1n ( L) x1t 1 1t

(2)
x 2t A20 A21 ( L) . . . x 2t 1 2t
. . . . . . . .
x nt An 0 An1 ( L) . . Ann ( L) x nt 1 nt
Where Ai0s are the parameters that variables included in the VAR system.
represent intercepts, and Aij(L)s are the Following Enders (2004), although it is
polynomial in the lag operator of L with possible to determine each lag length for
aij(1), aij(2), aij(3),… are Aij(L)‘s each variable, it is common to use the
individual coefficients. The terms εits same lag length for all variables in order
represent white-noise disturbances that to preserve a symmetric system. But,
might be correlated. Furthermore, there is a trade-off between
choosing the appropriate lag length is misspecifications and degree of freedom
important for the determination of the problems. If lag length is too long it will

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sacrifice degree of freedom, but if too relationship between variables included

short it might create misspecifications. in the VAR system. Enders (2004) shows
So, to determine the appropriate lag that in a multivariable case of (2),
length we use likelihood ratio tests or variable j does not Granger cause
alternative criteria such as the Akaike variable i if and only if all coefficients of
information criterion (AIC) or Schwartz Aij(L) are equal to zero. Often, we need
Bayesian criterion (SBC). The Granger to investigate causality among the
causality tests enable us to variables in the system, for example, if
we have the multivariate VAR as
determi
x1t a10 a11 a12 a13 a14 x1t 1 1t
ne the
x 2t a 20 a 21 a 22 a 23 a 24 x 2t 1 2t
`
x 3t a30 a31 a32 a33 a34 . . (3)
x 4t a 40 a 41 a 42 a 43 a 44 x nt 1 nt
If we define zt = x1t and xt = (x2t 5. Results and Analysis

x3t x4t )‘ and the test that xt GC
zt In this study, four variables
is a standard F-test with restrictions of all (economic growth, indicator of financial
coefficients in xt are zero in the first development, interest rate and price) are
equation. used in each model. Since there are three
However, the test that zt indicators of financial development, the
GC
xt involves restrictions on ratio of M2 to GDP (M), the ratio of
commercial bank assets to total bank
three equations of x2t x3t x4t. Under H0 :
assets (BA) and the ratio of private credit
α21 = α31 = α41= 0, the Granger causality
to GDP (PR) are used for estimation
test is the likelihood ratio test (LR) =
purposes. Whereas real GDP per capita
dofc[ln|ΩR| - ln|ΩUR|], where dofc is the
(Y), nominal interest rate (I) and
number observations minus the number
consumer price index (P) are used as the
of variables involved in the unrestricted
proxy of economic growth, interest rate
model and |Ω| is the determinant residual
level and inflation rate respectively. So,
covariance of the maximum likelihood
there are three main models in the
estimation (MLE). Under the null
relationship between financial
hypothesis, the LR test is distributed as
development and economic growth as
a χ2 with degree of freedom the number
presented in
of restrictions.

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Table 1.
Table 1 Three main models

Model Variable
1 Y, M, I, P
2 Y, BA, I, PR
3 Y, PR, I, P
Following Enders (2004), unit root test integrated of the same order and the
using the Augmented Dickey Fuller order must be greater or equal to one.
(ADF) Test is the first step in testing to The results of the test presented in Table
determine the order of integration. By 2 suggest that except for interest rate,
definition, cointegration requires each other variables are integrated of the order
variable included in the model to be one
Table 2 Unit Root Test
Variable I(0) I(1)
ADF Test 5 % critical ADF Test 5 % critical

value value
M -0.58 -3.52 -5.41 -3.52
BA -1.88 -3.52 -5.06 -3.52
PR -1.83 -3.52 -4.01 -3.52
Y -2.38 -3.52 -4.22 -3.52
I -6.40 -3.52 -7.26 -3.52
P -2.46 -3.52 -5.44 -3.52
Following Granger (1988), to investigate stationary is presented in Table 3 and the

the relationship between economic main result of Granger causality is
growth and financial development, the presented in Table 4, Table 5, and Table
Granger causality tests are performed. 6 (detailed data are presented in
The summary of optimal lag length, and Appendix A and Appendix B).
VAR

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Table 3 Lag length and VAR Stability Condition

Variable Optimal Criterion VAR Explanation
lag Stability
Y, M, I, P 1 AIC, BSC,LR, Stable AIC, LR, FPE

FPE
Y, BA, I, P 1 AIC, BSC,LR, Stable AIC, LR, FPE
FPE
Y, PR, I, P 1 AIC, BSC,LR, Stable AIC, LR, FPE

FPE
Money Supply and Output indicates that output does not respond
immediately to the shock in money
In contrast to Friedman and supply. The effect of money supply
Schwartz (1971) and Sims (1992), there shock increases in the second period, but
is no evidence that increasing money after that, the impact declines toward
supply in Indonesia will have a positive zero. In addition, the impulse response
impact on output. The Granger causality analysis (Appendix C) shows that neither
tests presented in Error! Reference the lower nor upper confidence band
source not found. suggests that money appears to be jointly positive. Therefore
supply does not influence interest rates we conclude that overall, there is no
and economic growth. Furthermore, the significant impact of change in money
impulse response analysis (Appendix C) supply on economic growth
Table 4 GC Test of Money, Output, Interest Rate and Price

GC Test F or LR test 5 % c.v Result Conclusion
Money GC others -0.804 7.815 Do not Reject H0 GC
M Y, I, P
Others GC Money 0.034 2.874 Do not Reject H0 GC
Y, I, P M
Output GC Others 0.211 7.815 Do not Reject H0 GC
Y M, I, P
Others GC Output 1.014 2.874 Do not Reject H0 GC
M, I, P Y
Output, Money GC 0.916 9.488 Do not Reject H0 GC
Y, M I, P
Interest, Price
Output, Price GC 1.956 9.488 Do not Reject H0 GC
Y, P M, I
Interest, Money

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Output, Interest GC -2.756 9.488 Do not Reject H0 GC
Y, I P, M
Price, Money
Conclusion Money Supply does not GC Economic Growth.
Economic Growth does not GC Money Supply.
Three factors cause influence economic activities which lead

ineffectiveness of money supply policy to an increase in economic growth. The
in influencing economic activities in economic crisis in 1997-1998 gave
Indonesia. The first factor is the failure additional evidenceof the ineffectiveness
of the money supply instrument as a tool of money supply manipulation. Although
to influence the interest rate. the Central Bank doubledmoney supply
Theoretically, as proposed by Ohanian in nine months, it could not prevent a fall
and Stockman (1995) and Hoover (1995) in economic growth of about minus 15
with their liquidity effect hypothesis, the percent.
Central Bank should be able to reduce This condition was worsened by
the short term interest rate that can boost the misperception of the Central Bank
economic growth via investment. about the specific economic relationship
However, as shown in the impulse between monetary policy and its effect
response analysis (Appendix C), there is on economic behavior. Following
no significant response of interest rates McLeod (2002), the Central Bank held
due to the shock on money supply the view that an increase in money
changes. Consequently, without policy would decrease interest rates and
capability of decreasing interest rate, boost economic activity. But, the data in
there is no channel for money supply to
Figure 1 do not support this view

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Figure 1 growth of money supply and interest rate

70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Growth of M2 interest rate
Source: International Monetary Fund, 2008. ‗International Financial Statistics‘,
http://www.imfstatistics.org/imf/ (02/04/2008).
Conversely,
Figure 1 shows that, the pattern

of interest rates follows the direction of
money supply growth. For example,
when the money supply growth
increased from 20 percent in 1994 to 28
percent in 1995, the interest rate also
increased from 13 percent to 17 percent.
The same pattern also happened in 1997-
1998 where an increase in money supply
growth was followed by an increase in

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the interest rate. Finally, when money ‗cut-off rate‘ (COR) system in the
growth increased from 8 percent in 2004 auction of the Bank Indonesia certificate
to 16 percent in 2005, the interest rate (SBI) as the money market instrument
also increased by 2 percentage basis used in open market operations.
points. One possible reason for this Different to the ‗stop out rate‘ system
anomaly is the inflation expectation of (SOR) in which quantity is
the public. Indonesians are still traumatic predetermined and the interest rate
by hyperinflation of more than 1000 follows money market equilibrium, in
percent at the end of Soekarno‘s COR, the Central Bank sets the SBI rates
presidency in the 1960s which destroyed (prices) and then the money market
the economy. As Mohamed (2000) determines the quantity of SBIs traded.
claims, the most important factor The predetermined interest rate in the
contributing to hyperinflation was due to COR system cannot attract the market to
money printing by the Central Bank to buy SBIs since the interest rate does not
finance the government‘s deficit. represent market equilibrium. As a
Consequently, the rise of money supply result, the quantity of SBIs sold are not
was noticed as the beginning of the as much as targeted, the over liquidity
increase in inflation. Furthermore, could not be absorbed, and the base
following McLeod (2002), the rise in money targeted, and hence M1 and M2
inflation is viewed as a decrease in could not be achieved. This condition
purchasing power and for this reason, was worsened by the lack of
economic agents need compensation by transparency in the auction system in
increasing income from deposits. On the which only limited parties in the money
other hand, borrowers realize there is an market were involved, so there was no
increase in the real future value of their competitive auction system. The
debt, so they are agreeable to pay a predetermined interest rate that did not
higher interest rate. represent market price and uncompetitive
Second, the improper system of markets created inefficiency in the
indirect monetary policy cannot absorb money market. This inefficiency led to
over-liquidity in the market. Gultom the failure of the money supply
(2008c) points out that after eliminating instrument to manipulate the interest rate
interest rate and credit control, the and therefore could not influence
Central Bank adopted an indirect investment and economic activities.
monetary policy using open market The lack of credibility of the
operations. The Central Bank set out the Central Bank and its personnel is the
operational target of base money (M0) third factor that influences the failure of
and intermediate target of narrow money the money supply in promoting
(M1) and broad money (M2). However, economic growth. As argued by
as pointed out by Sabirin (2003), until Tanuwidjaja and Choy (2006),
1993, the Central Bank introduced the credibility is important since the effect of

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monetary policy depends on public not increase the effectiveness of money

expectations. So, if the Central Bank supply in influencing economic growth.
lacks credibility, the public responds This finding is contrary to the argument
differently to the expectation targeted by of the Indonesian House of
the policy. The credibility of the Central Representatives (1999) and Pohan
Bank in Indonesia is not good because of (2008). They claim that the position of
several corruption scandals and political the Central Bank under the government
pressure. For example, as noted by the before 1999 caused ineffectiveness of
Indonesian Commission againts monetary policy, since the Central Bank
Corruption (KPK) (2006) several could not independently use its tools,
governors and other executives of the such as monetary policy to achieve its
Central Bank were prosecuted in court objectives. In addition, as stated by the
related to corruption. First, based on the Central Bank Act No. 23 / 1999,
investigation by the Audit Board of the independence of the Central Bank is
Republic of Indonesia (BPK), Sudrajad necessary to implement an effective
Djiwandono (the Central Bank‘s monetary policy in order to maintain and
Governor 1993-1998) was prosecuted improve economic development.
related to fraud in the allocation Rp 138 However, the data give a different
trillion liquidity credit of bank of conclusion. Including a dummy variable
Indonesia (BLBI) for 48 banks. Second, of 1 for the period after 1999 in the
the Bank Bali scandal on account model (Appendix B) shows that the
receivable factoring caused Syahril independence of the Central Bank does
Sabrin (Governor 1998-2003) to be put not increase the effectiveness of money
on trial. This case also involved the supply policy on economic growth. The
Minister of Finance, Bambang Subianto Granger causality test indicates that with
and a politician, AA Baramuli. Recently, independence, the money supply is still
Burhanuddin Abdullah (Governor 2003- ineffective as monetary instrument to
2008) and three executives were also influence economic activity. Consistent
accused in the case of bribery. Many with Swasono (2002), independence
corruption scandals and mismanagement without credibility and transparency not
in the Central Bank diminished the only fails as a guarantee to implement
confidence of the public in the Central effective and efficient policy, but can
Bank. As a result, when the Central Bank also create the opportunity of moral
releases a policy, the public often hazard of central bank‘s personnel that
responds negatively, and the objective of can dampen economic activity.
the policy cannot be achieved or it needs Interestingly, there is one
additional costs to reassure the public. important finding in the case of
An important result of this study Indonesia‘s economy. Differing from
related to monetary policy is that Schwartz (1987), the increase in money
independence of the Central Bank does supply does not induce an increase in

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price level. As shown in Error! stabilization program succeeded in

Reference source not found. and in the solving hyperinflation in the 1960s and
impulse response analysis (Appendix C), encourage economic activity at the end
the price did not respond immediately to of the 1960s. Furthermore Cummings et
the shock in the money. The price only al. (2006), state that even after
responded in the second period, but it Soeharto‘s presidency era, price
was not statistically significant and then, stabilization was still an important policy
the effect diminished until zero at period for political and social reasons,
6. One possible explanation for this is the especially related to food availability. As
existence of a price control policy a result, the effects of increasing the
through a price ceiling and subsidies for money supply on boosting inflation were
important goods such as rice and petrol. dampened by price stabilization policy.
Although criticized by many scholars
because the price stabilization program Bank Assets and Output
neglects the efficiency of resource
allocation, but, as pointed out by The Granger causality test
Mangkusuwondo (1973) the price presented in
Table 5 shows that the growth of Furthermore, the impulse response

commercial bank assets does not have a analysis suggests that, overall, there is no
significant impact on economic growth. significant and immediate impact of
Conversely, the increase in economic economic output, interest rate and price
activity does not play a significant role in level due to the shock on commercial
the growth of commercial bank assets. bank asset growth.
Table 5 GC Test of Bank Assets, Output, and Interest Rate, Price

GC Test For LR 5 % critical Result Conclusion
test value
Bank assets GC others 4.298 7.815 Do not Reject H0 GC
BA Y, I, P
Others GC Bank assets 0.274 2.874 Do not Reject H0 GC
Y, I, P BA
Y BA, I, P
BA, I, P Y
Output, Bank assets GC 6.371 9.488 Do not Reject H0 GC
Y, BA I, P
Interest, Price
Y, P BA, I
Interest, Bank assets
Output, Interest GC 0.86 9.49 Do not Reject H0 GC
Y, I P, BA
Price, Bank assets
Conclusion Bank assets does not GC Economic Growth.
Economic Growth does not GC Bank assets.

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In contrast to Gultom (2008a), in the banking sector diminished the

development of the financial sector as capability of preventing the banking
represented by the banking system does crisis that led to a financial crisis and
not have positive effect on economic eliminated the opportunity to promote
growth. Three possible reasons cause growth. So, the evidence indicates that
ineffectiveness of growth in commercial larger assets of a bank without an
bank assets in promoting economic increase in performance increase the
activities. The first is the blanket probability of insolvency and larger costs
guarantee of the Central Bank to prevent for bailing out, hence have a negative
systemic failure of banking industries. impact on the economy.
This implicit guarantee creates moral Second, most commercial banks
hazard of banking management in were unable to accomplish their normal
transferring credit risk to the Central function as intermediary institutions.
Bank. Banking industries tended to get Djiwandono (2005) notes that in the
excessive loans from foreign countries period before the 1997 crisis, many large
and gave credit to high-risk investments. banks tended to get excessive foreign-
As a result many banks had huge assets denomination loans from foreign
but poor performance. Fane and McLeod financial institutions and allocated the
(2001) suggest that a possible reason for credit to their own groups. As a result,
the relatively poor performance of the large assets without prudent banking
large banks is the confidence of those management and good corporate
banks that they were ―too large to be governance increased the level of non-
allowed to fail‖ due to the political and performing loans. After the financial
social impact of the large bank crisis, the commercial banks were still
liquidation. The data presented by Suta unable to improve their functions as
and Musa (2003) support the argument efficient intermediary institutions. But,
of Fane and McLeod (2001). For the reason was the low capability of the
instance, the liquidity credit of the real sector to absorb credit from the
Central Bank (BLBI) was given when a banking system and anxiety about the
bank faced a problem of insolvency or high-risk credit. As noted by Sunarto
liquidity and data in June 1997 (2007) the loan to deposit ratio (LDR) of
demonstrated that the seven biggest commercial banks in 1999-2003 were
debtors of BLBI that received 15.6 only between 45 percent ant 56 percent
percent of total BLBI were the large on average. Commercial banks tended to
banks with total assets on average of invest the liquidity surplus in Bank
more than Rp 5 trillion. At the same Indonesia certificates (SBI), inter-bank
time, total BLBI received by seven small lending, and government bonds. For
categorized banks was only 0.40 percent example, in October 2002, from
of the total BLBI. The chronic problem available deposits of about Rp 821

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trillion, the commercial banks invested Soeharto‘s cronies often influenced the
more than Rp 400 trillion in government decisions of major financial transactions.
bonds. Low capability of distributing This condition was worsened by the lack
credit is one reason for the of banking supervision and inadequate
ineffectiveness of growth in bank assets human resources in the banking sector.
to boost economic activity. As a result, many deregulations of the
The third possible reason is that banking sector failed to increase
the process of banking reform in efficiency and encourage economic
Indonesia was a more intricate process in growth.
political terms rather than based on Another important aspect that
economic and efficiency considerations. contributes to the ineffectiveness of
For example, Rosser (2002) states that in commercial bank assets in promoting
1967 the government tried to boost economic growth is the failure of growth
economic growth by banking sector in commercial bank assets in influencing
deregulation that enabled private foreign interest rate. As indicated by the impulse
and domestic banks to give credit. response analysis (Appendix C), the
However, the deregulation did not interest rate responds negatively on the
eliminate financial repression such as shock of bank assets in the first and
credit and interest rate control. Pangestu second periods, but in general the
(1996) demonstrates that although the response is not statistically significant.
credit from private foreign and domestic Theoretically, as argued by Lago-
banks grew significantly between 1974 González and Salas-Fumás (2005), large
and 1978, the state bank still dominated banks have more flexible alternatives to
almost 90 percent of the total credit. choose the best debtors and the most
Furthermore Rosser (2002) points out prospective projects because they have
that the main problem of this domination more capital and more bargaining power
was in the process of credit allocation than the small banks. Consequently,
where politicians and bureaucrats better opportunities induce efficiency
involved in the decisions on what level and enable large banks to adjust their
of interest rate subsidies and which interest rate. However, differing from
groups and sectors would be qualified for Lago-González and Salas-Fumás (2005),
the subsidized credit. Consequently, the larger assets and market power of
control of politico-bureaucrats led to Indonesia‘s commercial banks fail to
moral hazard and rent-seeking activities. decrease interest rates. Moral hazard,
Further banking reforms implemented in lack of banking supervision, and
1983 could not improve the fundamental ignorance of prudent banking
condition of the banking sector as the management cause inefficiency in the
anchor of financial stability. The banking sector. So, although the large
involvement of bureaucrats and the banks have more choices to allocate
family and conglomerates affiliated with credit in the most efficient way, these

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three factors prevent the banking sector

to cut the interest rate. Failure of the Differing from many empirical
interest rate adjustment causes failure of results such as McCaig and Stengos
promoting investment which hampers the (2005) and Thangavelu et al. (2004), the
ability of Indonesia‘s banking sector to growth credit of the private sector does
play a key role in promoting economic not have a positive impact on economic
growth. growth in Indonesia. The result of the
Granger causality test presented in
Private Credit and Output
(Appendix C) shows that overall, there is
no significant impact of output as a
response to the shock in private credit
Table 6 demonstrates that at 5 growth. Conversely, the private credit
percent significance level, the test sector has a positive significant response
statistic does not reject the null with the lag of one period on the shock
hypothesis that private credit does not of output, before diminishing in period 6.
Granger cause economic growth.
Moreover, the impulse response analysis
Table 6 GC Test of Private Credit, Output, Interest rate and Price

GC Test For LR test 5% critical Result Conclusion
value
Private credit GC -0.848 7.815 Do not Reject GC
PR Y, I, P
others H0
Others GC Private 10.27 2.874 Reject H0 GC
credit Y, I, P PR
Output GC Others 16.03 7.815 Reject H0 GC
Y PR, I, P
Others GC Output 0.661 2.874 Do not Reject GC
PR, I, P Y
H0
Output, Private credit 0.656 9.488 Do not Reject GC
Y, PR I, P
GC Interest, Price H0
Output, Price GC 20.21 9.488 Reject H0 GC
Interest, Private credit Y, P PR, I
Output, Interest GC 15.82 9.488 Reject H0 GC
Price, Private credit Y, I P, PR
Conclusion Private credit does not GC Economic Growth.
Economic Growth GC Private credit.
Three main factors influence the first is an aggressive credit expansion

ineffectiveness of private credit growth with fundamental weaknesses of the
to encourage economic activities. The banking sector. As Gultom (2008a)

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points out, the weaknesses consist of the attracting investment, and promoting
lack in banking supervision, human economic growth. However, the weak
resource management and the moral legal system and poor decisions from
hazard of conglomerate-owned banks in legal institutions in Indonesia increase
violating legal limit lending to their own the risk of default, and create a high-cost
group. For example, according to Suta economy due to inefficiency. For
and Musa (2003), 92 sample banks that instance, as claimed by a prominent
represent 85 percent of total assets in the foreign business, James Castel (cited in
banking system surveyed in June 1997 Athukorala (2002), the case of
related to insolvency problems. From Dharmala-Manulife insurance shows that
these banks, only 14 were categorized as there is almost no legal security for
sound and healthy. This indicates that doing business in Indonesia. This case
there were systemic problems in the was controversial since without legal and
banking system mainly due to the lack of rational reasons, the supreme court of
bank supervision and human resource Indonesia declared the bankruptcy of
management. In addition, violation of the Manulife insurance related to the legal
legal lending limit worsened the suit from Dharmala Corporation. In
condition of the banking sector in which addition, this case created uncertainty for
from seven major banks involved in the foreign investment, and increased the
liquidity credit of the Central Bank cost and default risk in Indonesia‘s
(BLBI), six were conglomerate-owned banking system due to the poor decision
banks. These conditions led to an from the legal institution. An increase in
escalation in non-performing loans default risk encourages creditors to
(NPL) averaging more than 10 percent increase interest rates, increases the cost
during 1994-1996. Increasing large NPL of accessing debtors‘ information and
in the banking sector worsens the consequently creates additional
condition of banks by reducing their inefficiency. As a result, increasing
profits, weakens their capability to offer private credit without reducing the cost
other credit, decreases investment and of capital due to high default risk
hampers economic growth. dampens productivity and economic
Second, lack of law enforcement growth.
and business certainty dampened the The third factor that plays a key
effect of private credit in promoting role in ineffectiveness of private credit is
economic growth. Consistent with the the failure of the Central Bank and the
empirical results of Djankov et al. government to recognize the
(2006), a strong legal system and law fundamental weaknesses of the banking
enforcement will protect both creditors sector. This condition is worsened by the
and debtors. Then, certainty in the irresponsiveness of these institutions to
business environment will improve take corrective action to improve
efficiency by reducing default risk, banking conditions. For example, Suta

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and Musa (2003) note that several years the financial systems are well-behaved,
before crisis, there was an aggressive and the empirical test results using all three
sharp increase in outstanding credit. financial development indicators
However, the credit was allocated to the (financial in-depth, commercial bank
private sector in domestic currency, but assets and credit allocated to private
the source of credit was obtained from sector) suggest that financial
foreign creditors in the foreign currency. development in Indonesia does not play a
This condition was aggravated by the key role in promoting economic growth.
fact that the liabilities side of the banking Many factors influence this failure, but
sector was dominated by short-term the most important aspect is the failure
loans, while the assets side was mostly of the financial system to adjust the
made up of middle and long-term credits. interest rate as one channel in promoting
However, the policy makers did not investment and economic growth. This
realize this and did not respond and act failure is mainly due to fundamental
properly to overcome the risk. Since the weaknesses in Indonesia‘s financial
government still implemented full system. These weaknesses are lack in the
financial liberalization with a fixed credibility, lack of the regulation, lack of
exchange rate policy, the banking sector law enforcement and weak
continued to obtain funds from overseas implementation of good corporate
without control and hedge position, and governance.
therefore increased exchange rate risk. First, lack in the Central Bank‘s
Consequently, when the financial crisis credibility diminishes the public
hit Indonesia, the rupiah depreciated confidence related to the policy
sharply and the asset-liabilities ratio of objectives. Inconsistency of
the banking sector decreased implementing and achieving target and
significantly toward insolvency. On involvement of several ministers and
December 1998 almost all banks in governors of the Central Bank in several
Indonesia suffered huge losses of up to banking scandals decreases significantly
12 percent of GDP. When the banking the trust of public in the monetary policy.
sector collapsed, the capability of The loss of confidence creates
allocating credit was eliminated, and the irresponsiveness of the public and they
real sector went bankrupt since the ignore central bank announcements and
working capital was no longer available. policy actions. As a result, a monetary
This condition decreased productivity policy such as an increase in money
and impeded economic growth. supply does not have a positive impact
on the economy. Lack of credibility also
6. Conclusions and Policy Implications encourages commercial bank personnel
to disobey the prudent principles both in
Differing from empirical obtaining funds and allocating credit.
research in developed countries, where They are confident that the monetary

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regulator will not give sanctions or Consequently, the growth of commercial

penalties for rule violations. bank assets is not in accordance with the
Second, lack of the financial health of banks and cannot encourage
regulation decreases the effectiveness of economic activities. An increase in credit
banking supervision. Transactions and allocated to the private sector cannot
operations in the banking sector change promote economic growth due to
rapidly, but the Central Bank often does weaknesses in the managerial capability
not adjust the regulation immediately to of the banking sector and operational
follow the development in the banking ability of the real sector.
sector. The inability to take corrective Lacks of fundamental factors in
action accurately and timely tends to the financial system are the main reasons
encourage banks and financial for the ineffectiveness of financial
institutions to disregard prudential development in promoting economic
regulations and sound management. growth. So, there are several
Implementing the blanket guarantee implications for monetary and financial
without sufficient supervision and policy. First, strengthening law
allowing banking sectors in pre-crisis enforcement will give a certainty to
1997 to borrow funds without hedging business environment and improve the
were evidences of insufficient credibility of regulatory institutions such
supervision and irresponsible regulation. as the Central Bank. Law enforcement
Third, lack of law enforcement can protect creditors by decreasing the
creates uncertainty in business and default risk and prevent moral hazard of
financial transactions. Inexistence of debtors. With a good legal system
penalties related to violation of legal creditors can obtain their right to sell
limit lending by conglomerate-owned credit collateral to repay unpaid loans.
banks increased non-performing loans This is not easy one because it involves
that reduced banks‘ profits significantly. not only the financial sector but also the
The inability of the legal system to judicial system, the government and
protect debtors in the case of default general awareness of the public.
increases default risk and the banking However, the financial sector can
sector compensates the risk by increasing improve this condition by increasing
interest rate which hampers economic cooperation with Indonesian
growth. Commission against Corruption (KPK).
Finally, weak implementation of Supporting data for corruption cases and
good corporate governance both in the knowing bank customers are two
financial and real sector diminishes the examples of action that can be taken by
function of the banking sector as an the financial sector.
intermediary institution. This decreases Second, implementing the policy
productive assets of banks and increases consistently can improve the Central
the risk of defaults and bankruptcy. Bank‘s credibility. For example, after

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announcing the inflation target and efficiency in supervision process, and

communicating the policy to the public, taking corrective action and enforcement
the Central Bank should consistently try for violation of regulation.
to achieve the target. If there is failure of Finally, to implement good
the target, and the Central Bank cannot corporate governance, more transparent
provide evidences that it is not its financial reports of banks as creditors
responsibility, there should be penalties and firms as debtors is important. In the
to the management of central bank, such banking sector, the clear disclosure of
as resignation. Another factor that can risky and long term investment such as
improve credibility is increasing the credit to its own group and to the real
transparency process of implementing estate sector will enable stakeholders to
the Central Bank‘s policy. For instance, monitor the banking condition. The full
establishing the independent commission disclosure of non-performing loans,
to evaluate and supervise the Central including its major debtors and the
Bank performance is one tool to prevent amount of loans can prevent moral
moral hazard of the Central Bank hazard of banking personnel and debtors.
personnel. This commission cannot The data of non-performing loans also
intervene to the monetary policy of the enable the Central Bank as banking
Central Bank, but it must ensure that the supervisor to take corrective action
Central Bank implements its policy timely and properly. Similarly, an
properly. obligation to provide full disclosure of
Third, improvement in banking financial reports for borrowers will
regulations is important to prevent moral enable banks to evaluate and give credit
hazard and mismanagement in the only for feasible project. Furthermore,
banking sector. Many banks ignored the improvement in accounting and auditing
lending rule, so the Central Bank should procedures is another instrument to
improve the standards, procedures, and increase the transparency of debtors.
transparency of the lending process. In Together with a good legal system,
particular, a blanket guarantee should not adequate financial statement disclosures
be given automatically to all banks, but it will decrease the default risk and
must be considered on a case-by-case consequently will be beneficial to the
basis. For example, banks that want to real sector in the form of lower interest
get a blanket guarantee are obligated to rate.
send data on a specific loan-by-loan Although this study uses a
basis. Then, only the credit allocated in comprehensive measurement of financial
proper manner that can be included in development and its relationship to
the guarantee. Next, the Central Bank economic growth, there are some
should strengthen the bank supervision limitations. Unavailability of longer and
by increasing the quality and integrity of more detail data of financial
supervisors, improving transparency and development is the major limitation in

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this study. Including development in the deeper analysis. Another possible study
capital market as another important for enrichment in this area is finding the
source of obtaining fund in the economy factors that influence economic growth
is another improvement to study in Indonesia. Preliminary research
comprehensively about the relationship (Appendix D) by the author of this paper
between financial development and indicates that international trade and
growth. However, since the capital foreign direct investment play an
market in Indonesia was inactive before important role in promoting growth in
1990 there is no data to be compared for Indonesia.
Appendices
Appendix A. Lag Length Test, VAR Estimates, and its Stability
A.1. Money Supply, Output, Interest Rate and Price
VAR Lag Order Selection Criteria
Endogenous variables: DLM DLY DI DLP
Exogenous variables: C
Date: 10/28/10 Time: 13:23
Sample: 1968 2009
Included observations: 37
Lag LogL LR FPE AIC SC HQ
0 4.019640 NA 1.17E-05 -0.001062 0.173092* 0.060336*
1 21.52746 30.28380* 1.09E-05* -0.082565* 0.788201 0.224420
2 28.96545 11.25749 1.79E-05 0.380246 1.947626 0.932821
3 37.78502 11.44161 2.87E-05 0.768377 3.032370 1.566541
4 49.14120 12.27695 4.38E-05 1.019395 3.980000 2.063147
* indicates lag order selected by the criterion
LR: sequential modified LR test statistic (each test at 5% level) SC: Schwarz information criterion
FPE: Final prediction error HQ: Hannan-Quinn information criterion
AIC: Akaike information criterion
Vector Autoregression Estimates
Date: 10/28/10 Time: 13:27 Roots of Characteristic
Sample(adjusted): 1970 2009 Polynomial
Included observations: 40 after adjusting endpoints Endogenous variables: DLM DLY
Standard errors in ( ) & t-statistics in [ ] DI DLP
DLM DLY DI DLP
Lag specification: 1 1
DLM(-1) 0.222820 0.051041 -12.93158 0.046494 Date: 10/28/10 Time: 13:28
(0.16030) (0.04934) (10.5780) (0.23687)
Root Modulus
[ 1.39005] [ 1.03448] [-1.22250] [ 0.19629]
0.326025 0.326025
DLY(-1) 0.073131 0.326764 61.12597 -0.428458 0.198498 - 0.267038

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(0.56387) (0.17356) (37.2100) (0.83323) 0.178628i

[ 0.12969] [ 1.88267] [ 1.64273] [-0.51421] 0.198498 + 0.267038
0.178628i
DI(-1) 0.000613 -0.000491 0.261768 0.002347 -0.255314 0.255314
(0.00239) (0.00074) (0.15762) (0.00353)
No root lies outside the unit
[ 0.25664] [-0.66750] [ 1.66072] [ 0.66499]
circle.
VAR satisfies the stability
DLP(-1) -0.020379 0.046290 -9.932701 -0.343647
condition.
(0.11599) (0.03570) (7.65441) (0.17140)
[-0.17569] [ 1.29652] [-1.29764] [-2.00490]
C 0.033219 0.016505 -1.292877 0.185627

(0.03569) (0.01099) (2.35520) (0.05274)
[ 0.93076] [ 1.50239] [-0.54895] [ 3.51970]
R-squared 0.054589 0.154254 0.200579 0.109913
Adj. R-squared -0.053458 0.057597 0.109217 0.008189
Sum sq. resids 0.464584 0.044017 2023.124 1.014466
S.E. equation 0.115212 0.035463 7.602865 0.170249
F-statistic 0.505233 1.595896 2.195427 1.080498
Log likelihood 32.35229 79.48367 -135.2279 16.73281
Akaike AIC -1.367615 -3.724183 7.011396 -0.586640
Schwarz SC -1.156505 -3.513073 7.222506 -0.375530
Mean dependent 0.043310 0.038220 -1.273000 0.123750
S.D. dependent 0.112251 0.036531 8.055478 0.170950
Determinant Residual Covariance 2.08E-05
Log Likelihood (d.f. adjusted) -11.46264
Akaike Information Criteria 1.573132
Schwarz Criteria 2.417571
A.2. Bank Assets, Output, Interest Rate and Price

Endogenous variables: DLB DLY DI DLP
Date: 10/29/10 Time: 16:02
Sample: 1968 2009
0 20.95293 NA 4.82E-06 -0.892260 -0.719882* -0.830929*
1 39.26375 31.80299* 4.29E-06* -1.013882* -0.151994 -0.707229
2 45.83960 10.03683 7.26E-06 -0.517874 1.033524 0.034102
3 55.83393 13.15044 1.08E-05 -0.201786 2.039121 0.595512
Vector Autoregression Estimates Roots of Characteristic Polynomial

Date: 10/29/10 Time: 16:05 Endogenous variables: DLB DLY DI DLP
Sample(adjusted): 1970 2009 Exogenous variables: C
Included observations: 40 after adjusting endpoints Lag specification: 1 1
Standard errors in ( ) & t-statistics in [ ] Date: 10/29/10 Time: 16:06
DLB DLY DI DLP Root Modulus
DLB(-1) -0.006734 0.111338 -39.35577 -0.311905 0.281131 - 0.178489i 0.333006
(0.16399) (0.07133) (14.4513) (0.34506) 0.281131 + 0.178489i 0.333006
[-0.04106] [ 1.56083] [-2.72333] [-0.90391] -0.303840 0.303840
-0.134586 0.134586
DLY(-1) 0.062063 0.246782 88.72501 -0.229344
(0.40600) (0.17660) (35.7775) (0.85428) No root lies outside the unit circle.
[ 0.15286] [ 1.39741] [ 2.47991] [-0.26846] VAR satisfies the stability condition.

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DI(-1) -0.000809 -0.000407 0.229135 0.002000

(0.00167) (0.00072) (0.14684) (0.00351)
[-0.48566] [-0.56152] [ 1.56046] [ 0.57056]
DLP(-1) -0.042968 0.045573 -9.779217 -0.345347

(0.08054) (0.03503) (7.09749) (0.16947)
[-0.53348] [ 1.30083] [-1.37784] [-2.03780]
C 0.020719 0.019613 -2.108414 0.187421

(0.02401) (0.01045) (2.11616) (0.05053)
[ 0.86280] [ 1.87768] [-0.99634] [ 3.70920]
R-squared 0.023891 0.185115 0.312191 0.129260
Adj. R-squared -0.087665 0.091985 0.233585 0.029747
Sum sq. resids 0.224158 0.042411 1740.664 0.992415
S.E. equation 0.080028 0.034810 7.052181 0.168389
F-statistic 0.214160 1.987713 3.971560 1.298923
Log likelihood 46.92816 80.22711 -132.2204 17.17232
Akaike AIC -2.096408 -3.761356 6.861019 -0.608616
Schwarz SC -1.885298 -3.550246 7.072129 -0.397506
Mean dependent 0.018728 0.038220 -1.273000 0.123750
S.D. dependent 0.076735 0.036531 8.055478 0.170950
Log Likelihood (d.f. adjusted) 9.339298
A.3. Private Credit, Output, Interest Rate and Price

Endogenous variables: DLPR DLY DI DLP
Date: 11/01/10 Time: 08:34
Sample: 1968 2009
0 -9.991969 NA 2.45E-05 0.736419 0.908797* 0.797750
1 17.61812 47.95437* 1.34E-05* 0.125362* 0.987249 0.432015*
2 26.39093 13.39008 2.02E-05 0.505740 2.057138 1.057716
3 33.26999 9.051389 3.53E-05 0.985790 3.226697 1.783088
Vector Autoregression Estimates Roots of Characteristic Polynomial

Date: 11/01/10 Time: 08:39 Endogenous variables: DLPR DLY DI DLP
Sample(adjusted): 1970 2009 Exogenous variables: C
Included observations: 40 after adjusting endpoints Lag specification: 1 1
Standard errors in ( ) & t-statistics in [ ] Date: 11/01/10 Time: 08:40
DLPR DLY DI DLP Root Modulus
DLPR(-1) 0.183243 -0.006714 -6.509803 -0.018713 0.404476 0.404476
(0.10473) (0.02617) (5.54111) (0.12391) -0.268638 0.268638
[ 1.74963] [-0.25651] [-1.17482] [-0.15102] 0.143412 - 0.183920i 0.233224
0.143412 + 0.183920i 0.233224
DLY(-1) 2.844484 0.328780 71.29975 -0.410228
(0.71699) (0.17917) (37.9339) (0.84830) No root lies outside the unit circle.
VAR satisfies the stability condition.

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[ 3.96725] [ 1.83496] [ 1.87958] [-0.48359]
DI(-1) -0.005931 -0.000534 0.256811 0.002283

(0.00299) (0.00075) (0.15811) (0.00354)
[-1.98472] [-0.71495] [ 1.62425] [ 0.64582]
DLP(-1) -0.062834 0.044712 -10.24091 -0.346171

(0.14513) (0.03627) (7.67851) (0.17171)
[-0.43294] [ 1.23281] [-1.33371] [-2.01600]
C -0.082138 0.019440 -1.906423 0.188500

(0.04321) (0.01080) (2.28634) (0.05113)
[-1.90072] [ 1.80015] [-0.83383] [ 3.68679]
R-squared 0.545793 0.130030 0.198068 0.109513
Adj. R-squared 0.493883 0.030605 0.106418 0.007743
Sum sq. resids 0.725033 0.045278 2029.481 1.014921
S.E. equation 0.143928 0.035967 7.614799 0.170287
F-statistic 10.51433 1.307823 2.161146 1.076087
Log likelihood 23.45081 78.91888 -135.2907 16.72383
Akaike AIC -0.922541 -3.695944 7.014533 -0.586192
Schwarz SC -0.711431 -3.484834 7.225643 -0.375082
Mean dependent 0.038815 0.038220 -1.273000 0.123750
S.D. dependent 0.202311 0.036531 8.055478 0.170950
Log Likelihood (d.f. adjusted) -17.55101
Appendix B. Granger Causality Test
B.1. Relationship Between Money, Output, Interest Rate and Price

M Y, I, P
Y, I, P M
Y M, I, P
M, I, P Y
Interest GC Others -2.188 7.815 Do not Reject H0 GC
I M, Y, P
Others GC Interest 2.636 2.874 Do not Reject H0 GC
M, Y, P I
Output, Money GC 0.916 9.488 Do not Reject H0 GC
Interest, Price Y, M I, P
Interest, Money Y, P M, I
Output, Interest GC -2.756 9.488 Do not Reject H0 GC
Price, Money Y, I P, M
Conclusion Money Supply does not GC Economic Growth.
B.2. Relationship Between Bank Assets, Output, Interest Rate and Price

Muh Dularif
GC Test F or LR 5 % c.v Result Conclusion

test
Bank assets GC others 4.298 7.815 Do not Reject H0 GC
BA Y, I, P
Others GC Bank assets 0.274 2.874 Do Not Reject H0 GC
Y, I, P BA
Y BA, I, P
BA, I, P Y
Interest GC Others -2.341 7.814 Do not Reject H0 GC
I BA, I, P
Others GC Interest 4.957 2.874 Reject H0 BA, I, P
GC
I
Output, Bank assets 6.371 9.488 Do not Reject H0 GC
GC Interest, Price Y, BA I, P
Interest, Bank assets Y, P BA, I
Output, Interest GC 0.86 9.49 Do not Reject H0 GC
Price, Bank assets Y, I P, BA
Conclusion Bank assets does not GC Economic Growth.
Economic Growth does not GC Bank assets.
B.3. Relationship Between Private Credit, Output, Interest Rate and Price
GC Test F or 5 % c.v Result Conclusion
LR test
Private credit GC others -0.848 7.815 Do not Reject H0 GC
PR Y, I, P
Others GC Private credit 10.27 2.874 Reject H0 GC
Y, I, P PR
Output GC Others 16.03 7.815 Reject H0 GC
Y PR, I, P
PR, I, P Y
Interest GC Others 0.927 7.815 Do not Reject H0 GC
I PR, Y, P
Others GC Interes 2.591 2.874 Do not Reject H0 GC
PR, Y, P I
Output, Private credit 0.656 9.488 Do not Reject H0 GC
GC Interest, Price Y, PR I, P
Output, Price GC 20.21 9.488 Reject H0 GC
Interest, Private credit Y, P PR, I
Output, Interest GC 15.82 9.488 Reject H0 GC
Price, Private credit Y, I P, PR
Conclusion Private credit does not GC Economic Growth.
Economic Growth GC Private credit.

Muh Dularif
B.4. Relationship Between Money, Output, Interest Rate and Price using dummy variable
(BI’s Independence)
M Y, I, P
Y, I, P M
Y M, I, P
M, I, P Y
Money, Interest GC -1.582 9.848 Do not Reject H0 GC
Output, Price M, I y, P
Conclusion With Central Bank,s Independence :
Money Supply does not GC Economic Growth,
Appendix C. Impulse Response

C.1. Money Supply, Economic Growth, Interest Rate, and Price
Response to Cholesky One S.D. Innovations ± 2 S.E.
Response of DLM to DLM Response of DLM to DLY Response of DLM to DI Response of DLM to DLP
.16 .16 .16 .16
.12 .12 .12 .12
.08 .08 .08 .08
.04 .04 .04 .04
.00 .00 .00 .00
-.04 -.04 -.04 -.04
-.08 -.08 -.08 -.08

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLY to DLM Response of DLY to DLY Response of DLY to DI Response of DLY to DLP
.05 .05 .05 .05
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DI to DLM Response of DI to DLY Response of DI to DI Response of DI to DLP

12 12 12 12
8 8 8 8
4 4 4 4
0 0 0 0
-4 -4 -4 -4
-8 -8 -8 -8
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLP to DLM Response of DLP to DLY Response of DLP to DI Response of DLP to DLP
.3 .3 .3 .3
.2 .2 .2 .2
.1 .1 .1 .1
.0 .0 .0 .0
121
-.1 -.1 -.1 Jurnal BPPK Vol. I Tahun 2010
-.1
-.2 -.2 -.2 -.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Muh Dularif
C.1.1. (DLM DLY DI DLP)

C.1.2. (DLY DLM DI DLP)
Response of DLY to DLY Response of DLY to DLM Response of DLY to DI Response of DLY to DLP
.05 .05 .05 .05
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLM to DLY Response of DLM to DLM Response of DLM to DI Response of DLM to DLP
.16 .16 .16 .16
.12 .12 .12 .12
.08 .08 .08 .08
.04 .04 .04 .04
.00 .00 .00 .00
-.04 -.04 -.04 -.04
-.08 -.08 -.08 -.08

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DI to DLY Response of DI to DLM Response of DI to DI Response of DI to DLP

12 12 12 12
8 8 8 8
4 4 4 4
0 0 0 0
-4 -4 -4 -4
-8 -8 -8 -8
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLP to DLY Response of DLP to DLM Response of DLP to DI Response of DLP to DLP
.3 .3 .3 .3
.2 .2 .2 .2
.1 .1 .1 .1
.0 .0 .0 .0
-.1 -.1 -.1 -.1
-.2 -.2 -.2 -.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
C.2. Bank Assets, Economic Growth, Interest Rate, and Price

C.2.1. (DLB DLY DI DLP)

Muh Dularif
Response of DLB to DLB Response of DLB to DLY Response of DLB to DI Response of DLB to DLP
.12 .12 .12 .12
.08 .08 .08 .08
.04 .04 .04 .04
.00 .00 .00 .00
-.04 -.04 -.04 -.04

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLY to DLB Response of DLY to DLY Response of DLY to DI Response of DLY to DLP
.05 .05 .05 .05
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DI to DLB Response of DI to DLY Response of DI to DI Response of DI to DLP
8 8 8 8
4 4 4 4
0 0 0 0
-4 -4 -4 -4
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLP to DLB Response of DLP to DLY Response of DLP to DI Response of DLP to DLP
.3 .3 .3 .3
.2 .2 .2 .2
.1 .1 .1 .1
.0 .0 .0 .0
-.1 -.1 -.1 -.1
-.2 -.2 -.2 -.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
C.2.2 (DLY DLB DI DLP)

Response of DLY to DLY Response of DLY to DLB Response of DLY to DI Response of DLY to DLP
.05 .05 .05 .05
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLB to DLY Response of DLB to DLB Response of DLB to DI Response of DLB to DLP
.10 .10 .10 .10
.08 .08 .08 .08
.06 .06 .06 .06
.04 .04 .04 .04
.02 .02 .02 .02
.00 .00 .00 .00
-.02 -.02 -.02 -.02
-.04 -.04 -.04 -.04

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DI to DLY Response of DI to DLB Response of DI to DI Response of DI to DLP
8 8 8 8
4 4 4 4
0 0 0 0
-4 -4 -4 -4
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLP to DLY Response of DLP to DLB Response of DLP to DI Response of DLP to DLP
.3 .3 .3 .3
.2 .2 .2 .2
.1 .1 .1 .1
.0 .0 .0 .0
-.1 -.1 -.1 -.1
-.2 -.2 -.2 -.2

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
C.3. Bank Assets, Economic Growth, Interest Rate, and Price

Muh Dularif
C.3.1. (DLPR DLY DI DLP)

Response of DLPR to DLPR Response of DLPR to DLY Response of DLPR to DI Response of DLPR to DLP
.20 .20 .20 .20
.15 .15 .15 .15
.10 .10 .10 .10
.05 .05 .05 .05
.00 .00 .00 .00
-.05 -.05 -.05 -.05
-.10 -.10 -.10 -.10

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLY to DLPR Response of DLY to DLY Response of DLY to DI Response of DLY to DLP
.05 .05 .05 .05
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DI to DLPR Response of DI to DLY Response of DI to DI Response of DI to DLP
8 8 8 8
4 4 4 4
0 0 0 0
-4 -4 -4 -4
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLP to DLPR Response of DLP to DLY Response of DLP to DI Response of DLP to DLP
.20 .20 .20 .20
.15 .15 .15 .15
.10 .10 .10 .10
.05 .05 .05 .05
.00 .00 .00 .00
-.05 -.05 -.05 -.05
-.10 -.10 -.10 -.10
-.15 -.15 -.15 -.15

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
C.3.2. (DLY DLPR DI DLP)

Response of DLY to DLY Response of DLY to DLPR Response of DLY to DI Response of DLY to DLP
.05 .05 .05 .05
.04 .04 .04 .04
.03 .03 .03 .03
.02 .02 .02 .02
.01 .01 .01 .01
.00 .00 .00 .00
-.01 -.01 -.01 -.01
-.02 -.02 -.02 -.02

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLPR to DLY Response of DLPR to DLPR Response of DLPR to DI Response of DLPR to DLP
.25 .25 .25 .25
.20 .20 .20 .20
.15 .15 .15 .15
.10 .10 .10 .10
.05 .05 .05 .05
.00 .00 .00 .00
-.05 -.05 -.05 -.05
-.10 -.10 -.10 -.10

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DI to DLY Response of DI to DLPR Response of DI to DI Response of DI to DLP

12 12 12 12
8 8 8 8
4 4 4 4
0 0 0 0
-4 -4 -4 -4
-8 -8 -8 -8
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Response of DLP to DLY Response of DLP to DLPR Response of DLP to DI Response of DLP to DLP
.20 .20 .20 .20
.15 .15 .15 .15
.10 .10 .10 .10
.05 .05 .05 .05
.00 .00 .00 .00
-.05 -.05 -.05 -.05
-.10 -.10 -.10 -.10
-.15 -.15 -.15 -.15

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Muh Dularif

Muh Dularif
Appendix D. Factors influencing economic growth in Indonesia

Muh Dularif
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JURNAL BPPK

Volume 1, Nomor 4, Oktober 2010

Financial Development and Economic Growth:

93 Jurnal BPPK Vol. I Tahun 2010

Financial Development and Economic Growth:

oleh : Muh Dularif

This paper empirically investigates the relationship between financial

Keywords: financial development, economic growth, vector autoregressive (VAR).

Pegawai pada Direktorat Jenderal Pajak

94 Jurnal BPPK Vol. I Tahun 2010

1. Introduction investors. The overall impact was growth

95 Jurnal BPPK Vol. I Tahun 2010

Similar to many developing price level is measured by consumer

96 Jurnal BPPK Vol. I Tahun 2010

liquidation of capital investment. Other Several recent empirical studies

97 Jurnal BPPK Vol. I Tahun 2010

there is still an unclear relationship problems, the government established

98 Jurnal BPPK Vol. I Tahun 2010

In contrast to Schumpeter (1934) feel richer, so they will be encouraged to

99 Jurnal BPPK Vol. I Tahun 2010

100 Jurnal BPPK Vol. I Tahun 2010

economic growth is through interest rates (1)

x1t A10 A11 ( L) A12 ( L) . A1n ( L) x1t 1 1t

101 Jurnal BPPK Vol. I Tahun 2010

sacrifice degree of freedom, but if too relationship between variables included

If we define zt = x1t and xt = (x2t 5. Results and Analysis

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Table 1 Three main models

Table 2 Unit Root Test

Variable I(0) I(1)

ADF Test 5 % critical ADF Test 5 % critical

BA -1.88 -3.52 -5.06 -3.52

PR -1.83 -3.52 -4.01 -3.52

Y -2.38 -3.52 -4.22 -3.52

I -6.40 -3.52 -7.26 -3.52

P -2.46 -3.52 -5.44 -3.52

Following Granger (1988), to investigate stationary is presented in Table 3 and the

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Table 3 Lag length and VAR Stability Condition

Y, M, I, P 1 AIC, BSC,LR, Stable AIC, LR, FPE

Y, PR, I, P 1 AIC, BSC,LR, Stable AIC, LR, FPE

Table 4 GC Test of Money, Output, Interest Rate and Price

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GC Test F or LR test 5 % c.v Result Conclusion

Three factors cause influence economic activities which lead

Figure 1 do not support this view

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Figure 1 growth of money supply and interest rate

Figure 1 shows that, the pattern

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monetary policy depends on public not increase the effectiveness of money

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price level. As shown in Error! stabilization program succeeded in

Table 5 shows that the growth of Furthermore, the impulse response

Table 5 GC Test of Bank Assets, Output, and Interest Rate, Price

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In contrast to Gultom (2008a), in the banking sector diminished the